Page 48 - DECO405_MANAGERIAL_ECONOMICS

Unit 4: Consumer Behaviour (Utility Analysis)

Introduction Notes

In economic theory, consumer behavior addresses the concepts of consumer preference and
consumer surplus. Consumer surplus is the extra amount a consumer is willing to pay for a
good, but he actually paid less for the good. A consumers' surplus can exist only within the
context of the concept of diminishing marginal utility. This concept holds that, at some point,
consumption of additional incremental quantities of a good will yield successively smaller
increases in utility. Thus, it is assumed that an individual will be willing to pay more for the first
unit of consumption than for a unit consumed at some point further along.

Notes Utility Analysis
The decision of a consumer depends upon the concept of individual benefit, also known as
utility. If consumer gets more benefit from the product he will ready to spend more on the
product and the vice-versa. Consumers are able to order their preference depending on
the utility they get from the consumption of the particular product. Utility can be difficult
to measure. No consumer is able to measure the utility in quantitative terms. But he can
order his preference according to the satisfaction from the consumption goods. Thus,
there are two class of thoughts about the measurement of utility. One states that utility can
be measured in numbers or monetary terms, another says that satisfaction utility derived
from the consumption of goods can only be ordered. These two distinctions are called
cardinal utility and ordinal utility.

4.1 Cardinal and Ordinal Utility

Utility is an economic term referring to the total satisfaction received from consuming a good or
service. For example, satisfaction you get by consuming a cup of tea is the utility of that cup of
tea. If this measure is given, one may think of increasing or decreasing utility, and thereby
explain economic behavior in terms of attempts to increase one’s utility. Changes in utility are
sometimes expressed in fictional units called utils. There are mainly two kinds of measurement
of utility implemented by economists: cardinal utility and ordinal utility.
Utility was originally viewed as a measurable quantity, so that it would be possible to measure
the utility of each individual in the society with respect to each good available in the society, and
to add these together to yield the total utility of all people with respect to all goods in the
society. Society could then aim to maximise the total utility of all people in society, or equivalently
the average utility per person. This conception of utility as a measurable quantity that could be
aggregated (summed up) across individuals is called cardinal utility.
Cardinal utility quantitatively measures the preference of an individual towards a certain
commodity. Numbers assigned to different goods or services can be compared.

Example: For a coffee addict, a utility of 100 utils towards a cup of cappuccino is twice as
desirable as a cup of tea with a utility level of 50 utils.
The concept of cardinal utility suffers from the absence of an objective measure of utility.
For example, the utility gained from consumption of a particular good by ‘A’ will be different
than ‘B’.
Ordinal utility represents the utility, or satisfaction derived from the consumption of goods and
services, based on a relative ranking of the goods and services consumed. With ordinal utility,
goods are only ranked only in terms of more or less preferred, there is no attempt to determine
how much more one good is preferred to another.

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